Monday, November 14, 2011

Competitiveness In A Currency Union

Is it reasonable to expect German taxpayers to make a potentially unlimited commitment to fiscal transfers to Spain and Italy? Maybe not. Certainly it sounds unappealing. Certainly Americans have no appetite for making that kind of commitment to the population of Mexico, even though the U.S. and Mexico share very close relationships across a variety of fronts. At the same time, the United States and Mexico don’t share a currency.

By contrast, Kentucky (population 4.3 million) and the San Francisco / Oakland / Fremont Metropolitan Statistical Area (population 4.3 million) do share a currency. They do this despite the fact that Kentucky has a longstanding lack of competitiveness relative to San Francisco. Eighty-seven percent of San Franciscans have high school degrees compared to just 80 percent in Kentucky. Forty-three percent of San Franciscans have bachelor’s degrees to just 20 percent of Kentuckians. Not surprisingly, San Francisco’s workers are much more productive, earning a median household income of $74,000 to Kentucky’s $40,000.

The way this is made to work is by long-term, sustained, open-ended financial transfers to Kentucky. Overall taxation in the United States is not very redistributive because state and local governments use regressive tax bases. But that means that federal taxes and transfers — i.e., the ones that matter for the SF/Kentucky relationship — are highly redistributive. Hard work, prudent investment, and human capital development in San Francisco are taxed to support indolence in Kentucky. And note that it’s not just poor people in Kentucky who are winning out in this arrangement. Kentucky is full of doctors and hospital administrators who think of themselves as hard working, highly educated professionals working in the private sector. But they’re living in a dreamland where their customers can afford their services thanks to taxes paid in San Francisco. Absent Medicare and Medicaid, health care professionals in Kentucky would see their incomes plummet with secondary consequences for the people who those professionals buy goods and services from. Nor does San Francisco demand any kind of conditionality for this assistance. Kentucky is not, to my knowledge, doing anything on the structural side to ameliorate its fundamental lack of competitiveness. What’s more, the structure of San Francisco to Kentucky transfers is perverse. If Kentucky implements new bad anti-growth policies, it will get more transfers from San Francisco. If it improves its policies and finds a way to grow, the transfers will diminish.

And yet, while there of course are people who argue for making the tax code more regressive, for cutting Medicare, and for cutting Medicaid there’s nobody who runs for office by objecting to SF/Kentucky transfers as such. What we have is a classic left-versus-right dispute about progressive taxation and income redistribution. That’s because Americans, whether in San Francisco or in Kentucky, generally conceive of ourselves as all living in one country. We act either on behalf of narrow personally selfish claims or else broad idealistic concerns about what’s right and proper for the country as a whole. But if that spirit broke down, the whole national economy would have a very different feel.

Update

My colleague Judd points out that the U.S. did, in fact, stage a brief Mexio bailout back in the late-1990s.

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